Apr. 13th, Sean Crockett, Ph.D. – Do Reference Dependent Preferences Really Matter?

Bio:  Sean Crockett is an assistant professor in the Department of Economics and Finance at Baruch College, City University of New York.  He received his Ph.D. from Carnegie Mellon University in 2004 and was a postdoc  at Caltech for two years afterward.  His research has focused on market price dynamics and their micro-foundations, as well as the market-level consequences of behavioral biases.  His published papers appear in the American Economic Review, the Economic Journal, Economic Theory, and the Journal of Mathematical Economics.

Abstract:  The endowment effect is a well-known behavioral regularity in which a person values a good more when he is endowed with it. In their generalization of prospect theory to consumption bundles with multiple attributes, Tversky and Kahneman [1991] imply the endowment effect as a consequence of loss aversion and diminishing sensitivity in gains. It has since frequently been presumed that this form of reference dependent preferences will inhibit trade. However, in this paper it is demonstrated that loss aversion and diminishing sensitivity in gains also imply a dynamic momentum trading effect that increases exchange, so the net effect of such preferences on trading volume is ambiguous. In fact, the momentum trading effect is shown to completely cancel out the endowment effect in an important class of examples.